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They say interest is a silent killer in any business. This is because you don’t really notice the impact it has on your profitability until you can look at an accumulated amount over a period a time to see how much of your profit actually goes to interest. It turns out that the money taken out of a business by an entrepreneur or the owners can also be an unnoticeable drain on profitability. Many small and medium sized business owners treat their business finances as an extension of their personal finances instead of treating their business like an investment. What many fail to realize is that without a policy or process around how owners take money from their business they may be doing more harm than good to their bottom line.
How are you taking money from your business?
Generally speaking there are three different ways money finds its way out of a business and into the hands of the owners:
- Through payroll
- Cash being taken out at irregular intervals and categorized as “management fees”
- Dividends
Money can also find its way out of a business through expenses that get put through a company credit card. Here’s the potential problem that arises when there is no policy or process surrounding how owners take money out of their business: the withdrawal of money can cause disruptions to cash flow and create unnecessary pressure. In my personal experience cash going out to owners always happens at the worst time and usually coincides with other financial obligations that end up being postponed until the cash is available. This can result in a higher than normal accounts payable balance that in some cases can exceed the accounts receivable balance. This basically means that vendors are financing the money being taken out by the owners of a business.
A another problem that can be overlooked by an entrepreneur or business owner is that the money they take out is often not reflective of the job that they are doing or the contribution they are making to the business. Simply said, if they hired someone else to do the same job tasks they are doing every day that person would not earn the same wage that owners pay themselves. This is a problem because the profitability of a business (if looked at like an investment) should be reflective of people being paid competitively to complete the work required to deliver the products or services of your business to customers and clients. If an owner is taking out a disproportionate amount of money from the business it can difficult to figure out how profitable a business really is and what strategies can be used to increase profitability. The draws of cash from owners can misrepresent the results of a business.
Being a business owner means building something that will provide you with income and future value. The simplest solution for taking money from your business in a way that does not misrepresent profitability or hinder your ability to benefit from the risk you are taking by having the business is to pay yourself what your job is worth and put yourself on payroll. Then come up with a policy that allows you to take dividends or management fees based on profitability. This will do two things for you. First, it helps you figure out what your job tasks are and if necessary can help you hire someone to take the work over without impacting your bottom line. Secondly, a structure like this would help you really understand the profitability of your business and may lead to new discoveries about how to become more profitable based on your need to generate more personal income.
Cash is king for any business. Many entrepreneurs and business owners fail to realize that they can be sabotaging their profitability unnecessarily by not understanding the impact their cash withdrawals are having to the business. The fix is simple but the change habit may not be. If you can look at your business through the lens of it being an investment and not a personal ATM machine you may be surprised by how you change your management style and business decisions.
If you need some help looking at the finances and cash flow of your business, get in touch with us. At mlenow.ca we are focused on increasing the profitability of your business which will increase its value and provide you with the opportunity to do more.
You should visit mlenow.ca because every business needs access needs access to money (at some point).
